Labor price variance, or rate variance, measures the difference between the budgeted hourly rate and the actual rate you pay direct labor workers who directly manufacture your products. Labor efficiency variance measures the difference between the number of direct labor hours you budgeted and the actual hours your employees work. Compare these two variances to determine how well your small business managed its direct labor costs during a period.

About Labor Variances

A labor variance that is a positive number is favorable and can result in profit that is higher than expected. A favorable variance occurs when your actual direct labor costs are less than your standard, or budgeted, costs. A labor variance that is a negative number is unfavorable and can result in profit that is lower than expected. An unfavorable variance occurs when actual direct labor costs are more than standard costs.

Labor Price Variance Calculation

Labor price variance equals the standard hourly rate you pay direct labor employees minus the actual hourly rate you pay them, times the actual hours they work during a certain period. For example, assume your small business budgets a standard labor rate of $20 per hour and pays your employees an actual rate of $18 per hour. Also, assume your employees work 400 actual hours during the month. Your labor price variance would be $20 minus $18, times 400, which equals a favorable $800.

Labor Efficiency Variance Calculation

Labor efficiency variance equals the number of direct labor hours you budget for a period minus the actual hours your employees worked, times the standard hourly labor rate. For example, assume your small business budgets 410 labor hours for a month and that your employees work 400 actual labor hours. Also, assume your standard labor rate is $20 per hour. Your labor efficiency variance would be 410 minus 400, times $20, which equals a favorable $200.

Labor Variance Factors

Labor price variance and labor efficiency variance might be favorable or unfavorable for various reasons. For example, you might use newer workers who receive lower pay than usual, which would create a favorable labor price variance and could increase your expected profit. These workers might have insufficient training and might require more hours to complete a job. More labor hours would create an unfavorable labor efficiency variance, which could decrease your expected profit.

Comparing Variances

Comparing labor price variance to labor efficiency variance helps you pinpoint areas of strength and weakness in your small business’s labor management. For example, if your labor price variance is a favorable $500, but your labor efficiency variance is an unfavorable $700, the unfavorable amount offsets the favorable amount. Consult with the manager in charge of your direct labor employees to determine the underlying cause of your variances and determine what you need to improve for the next period.